Are you mad to keep your money in prize bonds?

There has never been as much money in State-backed prize bonds as there is now. And yet the returns on offer haven't been as low in more than 10 years.

“People are still scared of investing and they will always be drawn to bank accounts and prize bonds,” notes Fonz Scanlan, a certified financial planner with Money Smart.

But could people be putting their financial health at risk by going overweight in prize bonds? And should people start making a move?

How do prize bonds work?
Prize bonds have always been popular with Irish savers, as they are State backed, tax free and give people the chance of winning substantially more than they might earn from a deposit.

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When you buy a prize bond, rather than receive an interest rate on your investment, you’re actually buying entry to multiple prize bond draws, which pay out a certain rate of prizes, until you withdraw your money. But their popularity tends to ebb and flow.

Back in 2009, for example, annual sales of prize bonds stood at about €369.6 million while the total prize fund was just €1 billion. This is likely because banks were paying hefty deposit rates, of as much as 5 per cent at the time to bolster their balance sheets. That made prize bonds less attractive.

Fast forward to 2014, however, when annual sales hit €475 million, and prize bonds started to take off, with a number of years of double-digit growth in sales. The reason for this, one presumes, is because deposit rates started to plummet at the banks and prize bonds had an average interest rate of 1.6 per cent – in terms of prizes paid out to bonds in issue.

Last year, prize bonds reported sales of €574 million a year, as the size of the gross fund hit a new high, of €3.4 billion. What doesn’t make sense, this time around, is when you consider just how much the prize pot has shrunk.

Returns through the years
The value of the prize fund is determined by the National Treasury Management Agency (NTMA) via the application of an interest rate to the value of outstanding Prize Bonds. The lower the rate, the lower the value of prizes on offer.

At the moment, an interest rate of just 0.5 per cent is applied – down from 3 per cent in 2012 – and has been since August 2017. With a total fund of €3.4 billion, some 0.5 per cent, or about €17 million, will be paid out in prizes each year. Last year, some €16.4 million was paid out in 224,474 prizes.

But contrast this with 2009 for example, when the interest rate was 3 per cent, and around €27.8 million was paid out in a similar amount of prizes (222,709).

Or how about 2013, when the number of prizes paid out peaked. At the time, the interest rate was between 1.75 per cent and 2.25 per cent, a decent rate of return, which meant that there was a prize fund of some €35.2 million, with 475,116 prizes paid out, or some 9,136 prizes a week.

The interest rate has dipped substantially since then, which means that the prize fund has shrunk by more than 50 per cent from 2013 to 2018, and the number of prizes by a similar proportion, to just 4,316 a week. Not only that, but the number of million euro prizes has also decreased, down from one a month back in 2012 to just two a year now. This means that just 21 prizes out of about 4,300 a week are for any sum over €50.

The average rate of return on prize bonds is 0.5 per cent. And this may not even apply to you

With some 576 million prize bonds outstanding, this means someone with €100 invested (16 prize bonds) would have only a one in 36 million chance of winning the top prize each time the draw is held. By contrast, the odds of winning the Lotto jackpot are 1 in 45 million.

However, with €10,000 (1,600 prize bonds), your odds would jump to one in 360,000.

The interest rate environment
Of course, the surge in popularity in prize bonds comes against a background of dismal returns available on deposit elsewhere. Place your savings with a retail bank and you'll struggle to earn more than 0.5 per cent a year. This means that on a deposit of €10,000, you'll just €50 a year.

And of course you’ll have to pay Dirt (at 37 per cent) on that. And if you have multiples of €100,000 to keep on deposit, and want to spread around to ensure that they’re all covered by the deposit scheme, you’ll struggle to find enough institutions paying even this.

So, the thoughts of potentially winning as much as €1 million, just by keeping your money in prize bonds – or if not, at least getting a return of 0.5 per cent, with no Dirt – is possibly what keeps many people invested.

“There’s no denying that that’s attractive,” says Scanlan.

The chances of winning
But one point that isn't always exactly understood is that the average rate of return on prize bonds is 0.5 per cent. And this may not even apply to you.

The interest rate on a prize bond isn’t a guaranteed rate of return. So just because you invest €1,000 in prize bonds, for example, doesn’t mean that you’ll get €5 back a year. It just means that you have a chance of doing so.

So, unlike your deposit account, which has a guaranteed return, you’re taking a bit of a bet with a prize bond. And how big this bet is can be difficult to determine. It also means that you’ll likely need a substantial amount in prize bonds to get any kind of a return at all; consider all those people who have received gifts of €50 or €100 in prize bonds and have never won at all.

Scanlan suggests that you’ll probably need at least €10,000 in prize bonds before you start making any return by winning in the draws.

If you put €100 into a prize bond 10 years ago - it's still worth €100 today, but what you can buy with it is less

“Some clients I’ve met say, ‘I love my prize bonds as I get a letter to tell me I’ve won €50’. But what I want to say is start a spreadsheet and write down all these €50 prizes and at the end of year add them up”.

Problematic?
But if it's only a bit of fun, and gives people the chance to win €1 million, what's the harm? This might be true for people with small amounts saved. But the figures suggest some people may have six-figure sums in prize bonds; and financial advisers say this can be damaging to their financial health.

Inflation is one factor to consider. "This is something that people tend to not take into consideration as a risk, because they don't physically see the value of their money going down," says Steven Barrett, managing director of Bluewater Financial Planning.

However, if you put €100 into a prize bond 10 years ago - it’s still worth €100 today, but what you can buy with it is less. With deposit accounts, you will make a guaranteed return – even if it is low. “But with prize bonds you will never get money back unless you win it in a raffle,” he says.

And even though interest rates are very low at the moment, compounding will still have a snowball effect. As Barrett notes, the NTMA has other tax free savings products people can put their money into, such as the 10-year solidarity bond.

If you put €100 into this bond 10 years ago, you would have seen your money grow by 16 per cent over the period. So your €100 would be worth about €116 at the end of your term; unless you’ve won, which is highly unlikely, your prize bond will still be worth just €100.

For Scanlan, another big issue is when people already have more than enough cash in current and deposit accounts, and should be putting any extra cash into higher returning diversified asset classes.

“Instead it’s going into another deposit-like cash product,” he says, adding that some people think of prize bonds as an investment, “but prize bonds are really like a pseudo deposit account and that’s only what they should be compared to”, he says.

Savers who can afford to put money away over a four-year time horizon should be looking at the markets, and achieving a broader spread of asset classes, he says.

“If you have prize bonds, don’t kid yourself that this is a substitute for any kind of medium- to long-term investment: it’s not,” he advises, suggesting instead that people consider multiasset funds which target returns of between 2-4 per cent a year.

“Ultimately my worry is that it’s almost a barrier to certain people diversifying a bit further,” he says.

And, while prize bonds are tax free, that’s not so much of an issue in the current low-interest rate environment. “If you’re not getting anything [in terms of a return] it’s really a moot point,” says Barrett.

Prize Bonds: By the Numbers

Number in issuance: 576 million.
Cost per unit: €6.25.

Prize structure:

• €1 milllion x 2 a year.
• €50,000 x 50 times a year.
• €1,000 x 10; 52 times a year.
• €500 x 10; 52 times a year.
• €50 – all other prizes, or about 4,296 a week.